Social Security and the Earnings Test

School of Social Security & Medicare

Senior couple planning for retirement and discussing the social security earnings test

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Recently, our Vice President of Corporate & Retirement Plan Services shared some valuable insights around the ‘earnings test’ and how it can impact those receiving Social Security benefits. Read the short article below to learn if this test applies to your situation and how it might affect your retirement plan.

Social Security and the Earnings Test by Patricia L. Burris, CFP®

When you claim Social Security benefits prior to your Social Security defined Full Retirement Age (FRA) and continue to work, your benefits will be subject to the earnings test. In 2020, $1 will be withheld for every $2 earned over the annual threshold of $18,240, if you do not obtain FRA in 2020. The threshold increases significantly (to $48,600 in 2020) in the year you attain FRA at which time $1 will be withheld for every $3 you earn over the threshold. The earnings limit is effective January 1st each year and indexed annually.

Who is Subject to the Earnings Test?

Everyone receiving Social Security benefits prior to their FRA is subject to the earnings test. This includes widows and widowers receiving survivor benefits and minor children receiving benefits on a deceased parent’s record if the child earns over the annual limit. If a minor child is receiving benefits based on a parent’s work history and the parent is still living and under FRA, the earnings test for the child’s benefit will be subject to the amount earned by the parent.

How is the Earnings Limit Applied?

First Year

The first year you claim Social Security prior to your FRA, you are subject to a monthly earnings test beginning the month you start receiving benefits ($18,240 / 12 or $1,520 per month in 2020). Therefore you can earn as much as you want prior to the month you start your benefits.

Subsequent Years, Until the Year You Reach FRA

You are subject to an annual earnings limit each year after the first calendar year until the year you reach FRA. At the beginning of each year you will be asked to estimate how much you plan to earn. If your estimated earnings are less than the annual limit for that year, no Social Security benefits will be withheld.

The Year You Reach FRA

The earnings limit in the year you reach FRA is applicable only up to the months prior to the month you reach FRA and is much higher ($48,600 in 2020). This is a monthly earnings limit ($48,600/12 or $4,050 per month) if this is the first year you are claiming benefits, but an annual earnings limit if this is the second or subsequent year you are receiving benefits.  For example, if your month of birth is July and you turn FRA in 2020, you can earn $4,050 each month in January through June if this is the first year you are receiving benefits. If this is the second or subsequent year you are receiving benefits, you can earn a total of $48,600 between January and June.

What Earnings are Considered When Applying the Earnings Test?

Annual gross earnings as reported on your W-2 are used. Therefore, contributing to a 401(k) or similar retirement plan to reduce earnings subject to state and federal income taxes will not reduce earnings for the earnings test.  However, payments received “on account of retirement”, such as a severance package, are not subject to the earnings test.

It is important to note that the earnings of your spouse may be considered when applying the earnings test for your benefits. If you are claiming benefits based on your current spouse’s work record and your spouse is under FRA and continues to work, their earnings are considered when applying the earnings test for your benefits, even if you have already attained FRA. However, if you are claiming benefits on an ex-spouse’s record, only your current earnings and age are used when applying the earnings test.

Earnings Test for Self-Employed:

Regardless of how much they earn, self-employed individuals have to work less than 45 hours per month in their business, otherwise benefits claimed prior to FRA may be withheld.

How Benefits are Withheld if You Exceed the Earnings Test:

Once the Social Security Administration (SSA) determines you have exceeded, or will exceed the earnings test based on the estimated earnings you provided, they will calculate the amount to withhold and begin doing so right away. They will withhold payment of full benefit checks until they receive the full amount overpaid, at which time they will resume remitting your monthly benefit. They always withhold full monthly benefit checks, even if the last one withheld exceeds the amount of the overpayment. In this case, the SSA will refund the excess withheld as soon as your employer reports your earnings for the year for which the overpayment is applicable.

Withheld Benefits Added Back at FRA:

At your FRA, the Social Security Administration (SSA) recalculates your monthly benefit to take into account the amount of benefits withheld. The actual calculation of how they add back withheld benefits to determine your monthly benefit at your FRA is somewhat complicated. The example below will provide a general idea of how your benefit is determined at FRA.

Assume your FRA is 66 and you started taking benefits at age 62, which reduces your FRA benefit by 25%. You start receiving 75% of your Primary Insurance Amount (PIA) of $2,000 for a benefit of $1,500 per month. Also assume 50% of your benefits were withheld due to the earnings test. At your FRA, the SSA will increase your monthly benefit by 50% of your 25% age-62 reduction, or 12.5%, increasing your benefit to 87.5% of your PIA, or $1,750.

When to Apply for Social Security – That is the Question

Depending upon how much you will earn, sometimes it makes sense to apply early, even if you think you might be subject to the earnings test. For example, a widow or widower who has limited earnings and needs the extra income may need to go ahead and start receiving Social Security benefits. In this case, they need to make sure they plan accordingly and know that their full Social Security check will be withheld as soon as the SSA becomes aware they’ve gone over the limit.

There are different schools of thought about applying for Social Security prior to FRA. Some advisors think you should wait as long as you can, even to age 70, to apply for benefits so that you get the largest monthly amount available. Others, like those in my firm, tend to lean toward getting your Social Security benefit at your FRA, or earlier if you are no longer working, if you need to draw down your retirement nest egg to pay your living expenses. After all, your retirement nest egg can be left to your heirs, whereas your Social Security benefits generally cannot. However, sometimes there is a need for a higher earning spouse to delay receipt of their Social Security benefits to age 70 to provide for a larger survivor benefit at their passing. 

When to file for Social Security benefits is a decision that every person needs to fully understand before applying. Your Financial Advisor should be able to help you make an informed decision on the impact of filing for Social Security on your overall retirement income. If they don’t carefully consider the timing of when you should file for Social Security in your retirement planning discussions, then it’s time to find a new advisor.

If you are looking for assistance in planning your retirement, contact a member of the Meld Financial team. Be sure to visit Meld University regularly for economic updates, valuable articles and free events that can help you stay on the right track for your retirement goals.

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Mark McGarvey - President - Meld Financial

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